France: Larger mandates on the cards

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One more predicament has hit Agirc-Arrco, the French compulsory second pillar pay-as-you-go (PAYG) retirement scheme covering 30m private sector employees and retirees. In December 2013, Agirc leaders announced they would draw €2.9bn from institutions’ reserves this year to pay ongoing pensions and that reserves would dry up by 2017 if nothing was done to avoid it. This follows the March 2013 agreement reached by social partners to shore up the regime, which has been imperilled by the impact of the economic crisis as unemployment has hit contributions and demographic effects caused by the ageing cohort of baby-boomers (France’s population).

In spring 2013, Patrick Poizat, Agirc-Arrco board member and a representative of the French Confederation of Christian Workers (CFTC), predicted some relief. A broader reform of the social security pension was expected to help Agirc-Arrco’s finances, with a longer contribution period before individuals qualified for full retirement rights. Financial reserves were expected to grow again by 2018. A year later, the haemorrhage of financial reserves has not been fixed and a new set of reforms is needed to avoid a catastrophe within three years for Agirc and just a couple more for Arrco.

So what went wrong?

First, the 20 January 2014 pensions law, approved by Parliament in December 2013, does not help Agirc-Arrco’s finances greatly in the short term. It lengthens the contribution period to 43 years, but this unpopular measure is designed for those born after 1973 (those born in that year would retire in 2036 at 63 if they started to work at age 20).

Second, the deflationary pressures of the economic crisis wrecked last year’s plan to reduce Agirc-Arrco’s growing pension burden. Social partners had agreed to raise pensions by one percentage point less than inflation, without any decrease.

“At the time, the inflation forecast was 1.75% for 2013, recalls Poizat. But the final figure was only 0.74%.” If inflation had been at 1.75% as expected, the reform effect would have been felt – contributions would have followed salaries, more or less in line with prices, even if wage increases were less common, and a full percentage point would have been saved on pensions.

The effect has been huge on this PAYG system, with about €65bn of annual benefits (€63.8bn in 2012), as each percentage point saved shores up reserves by €650m. As inflation was less than 1%, retirees were upset that pensions were frozen – probably proportionately more upset with their loss of 0.74% of purchasing power than they would have been with a 1% purchasing power loss coupled with a 0.75% pension rise had inflation reached the foreseen 1.75%. Proportionately, Agirc-Arrco has also lost a quarter of the planned reform effect, which totals about €170m annually, given the cumulative effect of pensions increases over time.

Finally, the economic and demographic crisis is still affecting reserves. Despite a favourable market environment, Agirc-Arrco’s long-term reserves decreased by a combined €1.19bn in the first half of 2013 (the last available figures), to €46.023bn for Arrco (against €46.86bn at the end of 2012), and €6.035bn at Agirc (against €6.77bn at end 2012). Overall, during the five years of this financial crisis from 2009-13, Agirc and Arrco have together had to draw down €19.1bn from their long-term reserves to finance a growing pension burden with lower contributions.

Further reforms will be needed to restore Agirc-Arrco’s ability to manage retirement parameters with a sufficient long-term horizon. Social partners have postponed bargaining until they officially approve 2013 accounts, which is scheduled to take place this June. “A social partners’ meeting is already planned the same day in the afternoon to discuss the next negotiation agenda at the Medef employers’ headquarters in Paris,” says Poizat.

In the meantime, Agirc-Arrco is taking steps to find economies of scale and cost reductions as planned in last year’s reform. Article 8 of the March 2013 reform required a workgroup to propose further “cost rationalisation” initiatives, which were presented after the last meeting in late November. Many cost-savings measures rely on administrative and IT productivity gains – which include avoiding the dispatch of between 1.5m and 2.5m useless letters a year, cutting bank transfer fees on the €1bn pensions paid to retirees abroad, reducing management costs by €300m a year by 2018 from the €1.9bn level in 2012, of which €200m is to be saved on IT. Two main directions are of direct interest from an asset management perspective – concentration and centralisation.

Resolution 6 of the Agirc-Arrco rationalisation workgroup calls for further mergers between retirement institutions. This trend started in 1996, at a time when Agirc and Arrco regimes were scattered between 110 social protection groups (GPS), many with historic origins. After retirement rules were harmonised across Agirc and Arrco federations, a merger frenzy reduced the number of institutions to 18, and there will be 12 left by the summer once AG2R La Mondiale takes over Reunica, and other ongoing mergers are validated at Humanis,

which is also already incorporating Novalis-Taitbout and Aprionis. Other mergers are in the pipeline, as ProBTP is merging with five smaller specialised retirement institutions – Audiens, Agrica, IRP Auto, Lourmel and B2V – and Apicil is likely to join Humanis in the coming years.

Social partners want this new round of concentration to centre on four or five large institutions – AG2R La Mondiale, Malakoff-Médéric, Humanis Klesia (formerly Mornay and D&O) and ProBTP. As the five leading groups already account for 76% of Agirc-Arrco operations, they will encourage mergers of smaller institutions representing less than 10% of Agirc-Arrco operations, but would block institutions representing more than 30% of the system from taking over smaller ones to avoid concentration issues for insurance and asset management services in competition with other providers.

In this regard, 30% of Agirc-Arrco assets outsourced to fund managers are already captured by eight of the organisation’s own institutions’ asset management subsidiaries. This represents a real insider advantage considering Agirc-Arrco spent €138m in money-management fees in 2012 – an average 0.25% of its capital outsourced to 50 asset management firms.

Over the longer term the rationalisation effort could also change the game, as GIE Agirc-Arrco central body should play a greater role in managing long-term reserves and reduce delegation of management to decentralised institutions. Such a move could lead to more direct handling of investments, as other pension funds do, to reduce external fees. But this is not likely. “We do not consider asset management to be our job, and social partner management would carry additional risks,” explains Poizat.

Agirc-Arrco would rather retain its role to define investment policy, control implementation and monitor results. Asset concentration would help to control fees and could mean larger mandates for fewer asset managers in a more competitive and open environment.